Diamond Derivatives: Lessons from Indian Markets

1. Diamond Derivatives: Lessons from Indian Markets June 2007

2. Background • Economic reforms since 1991-92 • Foreign Exchange • Current account convertibility • Active derivatives market • Equity Market Reforms • Electronic trading platform • Active derivatives market • Fixed Income Market • Limited trading • Commodities Market • Active derivatives market

3. Structure of Financial Markets Equity Debt F/X Commodities

4. Equity markets Regulator Securities & Exchange Board of India (SEBI) Exchanges NSE/ BSE and other exchanges in India Presence of electronic dealing platforms Dematerialized trading for cash markets Limits on Foreign Institutional Investors relaxed over the period of time Futures and Options Market introduced during 1999-00 with daily settlement and margin requirements Features

5. Equity market – Cash v/s derivative segments USD billion More than proportionate increase in annual F&O segment turnover vis a vis the Cash segment turnover 1 USD = INR40.75

6. Currency markets Regulator Reserve Bank of India (RBI) through FEMA and Exchange Control guidelines Currency markets controlled by RBI till introduction of the Liberalized Exchange Rate Management System in 1992 Introduction of plain vanilla currency options by RBI in 2000-01 Structured swaps and exotic options Active Spot/Forward markets in USD/INR Features

7. Currency market turnover USD billion Source: Reserve Bank of India

8. Debt markets Regulator Reserve Bank of India (RBI) / FIMMDA guidelines Sovereign debt volume dependent on borrowing program of the Government of India (GOI) Active OTC - INR swap markets Less active non government bonds Interest rate futures less active Features

9. GOI securities - volumes Source: CCIL

10. Commodity markets Regulator Forward Market Commission Exchanges MCX, NMCE & NCDEX Fragmented commodity trading since 1875 New exchanges since 2004: Currently 3 active exchanges Over 60 commodities listed, however liquidity in less than 10 commodities Turnover doubles in 2007 to USD 1000 bn compared to 2006 Features

11. Commodity Futures – Daily Volumes Source: MCX, June 2006

12. Key observations • Equity and commodity derivatives markets • Very high volumes and high growth p.a • Active retail and institutional participation • Hedgers and traders provide liquidity • Number of participants very high • Fixed Income and Foreign Exchange markets • Largely institutional players • Reach restricted • Regulatory influence

13. Key Learning • High price volatility & liquidity • In commodities with international linkages and multiple listings • Derivative market trading volumes are 15 times the value of cash markets (Eg: Gold) • Diamond futures volumes to be around USD 150~200bn annually by this estimate • Traders & Speculators in Stock & Commodity markets similar in profile to Indian diamond community

14. Diamond Derivatives: Building Blocks • Bench mark reference • Need for active cash market • Standardised “commodity” • Market makers • Low bid offer – high liquidity • High volumes • Price discovery • Hedgers • Traders • Speculators • Investors

15. Diamond Derivatives: Building Blocks • Transparency & Price discovery • Pros and cons for Industry • Governance • Arms length and insider information • Exchange trading of commodities • Elimination of credit risk to participants • Market information for price volatility • Dissemination of information to market players

16. Diamond Industry in India • High importance to Indian Economy • Contributes over 15% exports (USD 12 billion) & 6% imports (USD 9 billion) • India accounts for over 90% volumes & 55% value in cutting & polishing of diamonds • Increasing trend in retail appetite for diamond jewellery • High GDP growth • Higher net disposable income • Continued Government support to promote this sector

17. Diamond Derivatives: Discussion Should Diamonds be listed in India? • Pros • Natural linkages with the industry • Market players to provide liquidity • Commodity Exchanges and Electronic trading platforms available • Provides arbitrage opportunities if listed else where internationally • Cons • Entry restrictions for foreign players • Initial regulatory interference

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